Lecture 5 - Valuation Flashcards
DCF Valuation
firm value = cash0 + (FCF1)/(1+WACC) + (FCF2)/(1+WACC)….
cash included in DCF
EXCESS CASH
only include cash not needed for day-to-day operations; cash that is free to be paid out
DCF valuation steps
- find EXCESS cash today (cash0)
- find PV of FCF estimates over non-constant growth period
- find PV of horizon/TV of FCF in constant growth period
non-constant growth period
diff growth rates during period
ends only when we can assume growth is stable
constant growth period
value of firm in this period = TV
beginning in year N+1, we assume expected FCF will grow at constant rate g
TVn
PV of all future FCFs in constant growth period discounted back to year N
TVn =
(FCFn+1) / (WACC-g)
firm value
PV of all future cash flows and today’s cash
Equity value (MV) =
Firm value - debt
what price should you be willing to pay at time 0 for stock? =
P0 = equity value / # of shares
mid-year discounting
FCF discounted as mid year cash flows
firm value w/ mid-year discounting =
cash0 + (1 + r)^1/2 * (PV FCF & TV)
TV using book values =
= book value of assets
= LT assets + NWC
TV using book values
a reasonable lower bound for a firm future value = future book value of assets
why is TV using book values a lower bound?
bc we expect market values to rise above book values
TV using multiples
find firm with similar business risk, growth prospects, and leverage
use its market multiple to predict TV of firm
APV formula =
VL = Vu + PV (financial side effects)
VL
value of project/firm accounting for how it’s financed
Vu =
sum of PV of all FCF discounted by ra
Σ (FCFt) / (1 + rA)^t
rA
unlevered return
return on assets
reflects only compensation for BUSINESS risk
possible financial side effects
interest tax shields
cost of financial distress
agency costs of debt
direct cost of issuing equity/debt
discount future tax shields by…
rD if firm is profitable
rA if firm is not profitable
appropriately accounts for riskiness
interest tax shields =
rD * D * T
(calculate for every year)
how much expected cash flows the firm saves on taxes bc of interest expenses
loans: principal @start of year =
(last year’s debt amount) * (1+rd) - equal payment
advantage of using APV
works well with time-varying D/V
gives clear picture of exactly how financing affects project value
tax shields are accounted for in WACC & APV by….
WACC - thru the discount rate
APV - thru financial side effects
WACC & APV make following assumptions about D/E
WACC - assumes constant D/E
APV - gives simple way to account for changes in D/E
EVA =
Cn - r*I
Cn = CF in period n (ex. FCF)
r = opp cost of capital (ex. WACC)
assumes you are tying up capital I forever
EVA investment rule
make investment if PV of all future EVA’s discounted at cost of capital (r) is positive
PV (EVA) =
Σ Cn / (1+r)^n - I = NPV
5 steps to multiples
- find comparable firms
- choose many scaling bases (EBIT, sales)
- calculate ave multiple for each scaling factor for comparable firms
- come up with projection for scaling factor for your firm
- use various multiples and projections to arrive at valuation
EPS =
NI / Shares outstanding
PE ratio =
Price per share / Earnings per share
how much investors are willing to pay per dollar of current earnings
higher PE ratio usually means….
firm has significant growth prospects / low expected returns
constant dividend growth model =
P0 = (DPS1) / (rE-g)
how does g impact PE ratio?
higher g = higher PE ratio
how does rE impact PE ratio?
higher rE (expected return) = lower PE ratio
how does payout ratio impact PE ratio?
higher payout ratio = higher PE ratio
if PEf > PEm
fundamental PE > market PE
stock is undervalued
should BUY stock
if PEf
SELL stock
PEf =
[b * (1 + g)] / (rE - g)
PEm =
P0 / EPS0
